Retail Casualties Rise

Shopping center sales dwindle as vacancy rates increase and rents fall at a record pace.

Don't be surprised on a long drive to find a strip mall or two abandoned along the highway, the empty parking lot and poking weeds looking eerily reminiscent of the 1980s, when foreclosures and savings and loan failures were rampant.

It's not farfetched to anticipate a slew of mall closures, says Victor Calanog, director of research at New York data firm Reis. “I think we're seeing it right now. We're seeing a lot of properties in distress. I think a lot of malls will go dark.”

Despite the differences in performance between regional malls and strip centers, both are facing difficulty. In the first quarter, the vacancy rate of regional malls reached a historical high of 7.9%, up from 5.9% a year earlier, says Calanog. The vacancy rate of strip malls also rose by 200 basis points to 9.5%. “It's something we haven't seen since 1994.”

As for retail property sales — forget it. “Nothing's really trading. The inventory of properties for sale is getting greater,” says Jessica Ruderman, senior analyst at New York-based research firm Real Capital Analytics, which tracks sales of $5 million or greater. From January through May, sales volume declined 70% from 2008 levels, Ruderman says.

Hampered by credit and valuation issues, investors are stymied. Through May 2009, retail property sales totaled $3.1 billion, a far cry from the $19 billion in sales over the same period of 2008, and dramatically less than the $62.2 billion recorded during the robust market of 2007.

Like investors, consumers are embattled. The nation's unemployment rate lurched to 9.5% in June, up from 9.4% the previous month, and it's small wonder that with payroll employment declining by 6.5 million since the recession started that Americans have put the brakes on spending.

Competition adds pressure

“Why would you go out there and spend?” asks Calanog. Personal incomes and 401(k) programs have taken a hit. Home prices are falling. “Your future expected income is under assault. You're not sure if you can keep your job.”

In the retail industry, traditional wisdom held that if a consumer lost his job, he would still drive to the neighborhood strip center and buy milk for his children, ensuring stability for grocery-anchored shopping centers. Purchases driven by necessity — for food, prescription medicine — gave grocery landlords an edge over mall owners whose tenants sold fashions and other non-necessities geared to discretionary spending.

But a new trend is profoundly affecting grocery and pharmacy-anchored strip centers: competition. Discounters like Wal-Mart, based in Bentonville, Ark., and Costco Wholesale Corp., based in Issaquah, Wash., have carved out grocery departments in their big box stores.

An estimated 40% of Wal-Mart's revenues come from groceries, according to Reis. Adding to the strain on supermarkets and their landlords, drug chains like Walgreens are expanding their grocery sections.

Retail tenants forced to downsize or face closure are pressuring landlords for concessions to ease their financial burdens. Meanwhile, conditions deteriorated markedly at the neighborhood and community centers in the first quarter. According to Reis, negative net absorption of 8.2 million sq. ft. set a single-period record in the first quarter.

Asking rents plunge

That wasn't the only unwelcome news. The change in asking rents of negative 0.6% for the strip centers was the biggest quarterly decline since 1999, Reis reports. Asking rents have dropped since the third quarter of 2008. Effective rents also fell at a dizzying pace in the first quarter, 1.8%, reflecting landlord concessions.

Retail rents have dropped in many cities. In Boston, the rate of $21.64 per sq. ft. in the first quarter was 0.8% lower than in the fourth quarter, according to Reis. In Atlanta, rents dropped 0.6% to $17.36 per sq. ft. But rents actually increased in a few cities like Charlotte, N.C., where the rate of $18.12 was 0.3% higher than in the previous quarter.

But most cities are unlikely to command higher rents anytime soon. “I'm not forecasting a recovery for retail until well into 2012,” says Calanog. Retail has the most pessimistic outlook of all the commercial real estate sectors, he says. Although recovery will take years, he concedes one point: “Everyone's waiting with bated breath.”